Finance & IT: the transforming power of technology; Over the years, technology has reshaped the finance function--and sparked a profound change in the way business is done. But, surprisingly, much has stayed the same. A look at the juncture of business, finance and technology.
The article went on to say that some of the questions "have been resolved with a minimum of detriment to mankind; but never in so short a time as the mechanization of the business and governmental worlds through the medium of electronic data processing." Referring to a then-current list of 500 areas of applications of computers, it queried: "In 1975, what will be included in such a list?"
Imagine how the answers have changed since then!
It's undeniable that since the formation of The Controllers Institute of America 75 years ago, much progress has been made in conducting business and, specifically, in the finance function. However, regardless of the changes, the basics remain: Every business needs its finance department to produce financial statements, develop budgets, manage the company's cash cycle and interact with the financial markets.
The same Financial Executive article notes that at that time, computer makers "view this century's alarm over [man] being exchanged for a machine on either the decision-making level or the labor-level jobs as the result of 'pure science fiction.' They say that computers are merely tools to help man do his work faster and better--and will remain so."
From information technology's (IT) earliest iterations, there's been a perpetual "man-versus-machine," which-drives-which struggle. Back in '65, we were assured man would win over the technology. Here in the 21st century, with technology moving faster and getting smarter and more sophisticated, this struggle shows no signs of ending; and the question about which drives which still remains.
Another insistent issue concerns how finance should interact with the "business." Some executives have hoped for finance to be a strategic partner, but finance people have not always had the personal style and business savvy needed to assume the strategic role.
Evolution of Finance And IT
Jeff Henley, chairman of enterprise software-maker Oracle Corp., helps to provide a good overview of changes in the finance function due to the influence of IT during his storied career. Henley, an FEI member, was previously the firm's CFO for 13 years (1991 through 2004). Prior to that, he served as CFO for another company. All told, his career spans 39 years, thus far, and in helping to drive two major technology companies, he's had more than a front-row seat to the interaction of finance and business.
Henley views technology and globalization as the two biggest forces for change in the finance function. Technology has helped speed up the production of financial statements, simplified the development of budgets and the analysis of performance to plan, streamlined the cash cycle and enhanced the communication among finance-department employees, as well as between finance and its constituents--among them, business units, investors, banks and insurance companies.
Technology has also enabled the globalization of finance. It's now possible to perform many of finance's core activities in a single, and often low-cost location--such as India or the Philippines, where labor rates are much lower than they are in, say, the U.S. Further, Internet access has enabled businesses to communicate with their central locations 24/7--increasing finance's productivity--along with its value to the business.
What follows is a capsule of some significant transformations in finance enabled by these trends, and most notably the evolution of IT. While it is difficult to pinpoint precisely when each trend began, they follow in order of when they happened. The idea is that these have built on each other--enabling the transformation of finance from a narrow function that produced internal cost-accounting data to a more strategic one that acts as a business partner with senior management. To map out this evolution, the following transformations will be examined:
* Internal accounting focus [right arrow] Internal and external accounting focus;
* Paper and calculators [right arrow] Centralized IT [right arrow] Distributed IT;
* Limited evaluation of planning scenarios [right arrow] Infinite evaluation of planning scenarios;
* Isolated functional departments [right arrow] Integrated cross-functional processes;
* Many separate geographic subsidiaries [right arrow] Centralized global shared services;
* Finance as support function [right arrow] Finance as business partner.
* Internal Accounting Focus [right arrow] Internal and External Accounting Focus
One of the most fundamental changes in the role of finance is the nature of the accounting it performs. Observers with extensive experience in finance echo this change. FEI member Malcolm Schwartz, chief operating officer of CRS Associates LLC, who has devoted significant time during his long career to developing management accounting systems, comments on the history of the finance function: "In the 1930s, accounting was much more oriented towards management accounting and internal control. But the securities laws enacted [in 1933] in the wake of the stock market crash changed the focus to public accounting and disclosure."
Thus, prior to the U.S. stock market crash in 1929, managers expected the finance function to produce information that would help with internal control. With the formation of the U.S. Securities and Exchange Commission (SEC) in the 1930s, however, the finance function became much more focused on external accounting.
From the 1930s to the 1980s, the SEC required that disclosure documents be filed exclusively on paper. Thousands of companies mailed the SEC hundreds of thousands of documents. Each document was date-stamped, copied, sent to various divisions for review and made available to the public for physical inspection in a Washington, D.C., library that is still maintained by the SEC at significant expense.
There's no question that technology has played an important role in external reporting. Certainly the SEC's Electronic Data Gathering, Analysis and Retrieval (EDGAR) system--which started in 1983 and went into use a decade later--has made it easier for investors to gain timely access to public filings. Analytical tools, such as spreadsheets, have made it easier for investors to analyze financial results and to develop forecasts. The ongoing development and deployment of extensible Business Reporting Language (XBRL) will make it even more efficient for public companies to share their financial results. The current SEC Chairman, Christopher Cox, is a strong proponent of XBRL.
In a May 2006 SEC press release announcing that three additional companies were joining the 17 already in a voluntary XBRL reporting program, Cox said, "Interactive data will vastly improve the delivery of financial information to individuals and institutions alike. It has the potential to slash hours of waste, cost and inefficiency--not just for the users of financial data, but for the companies that prepare it as well. Even more importantly, it will help level the playing field for tens of millions of average investors."
* Paper and Calculators [right arrow] Centralized IT [right arrow] Decentralized IT
The technology used in the finance function over the past 75 years has changed dramatically, and has driven a change in the way finance activities are performed. One instance of this evolution has taken place in the banking industry. For example, changes in the way banking functions such as credit authorization and check-clearing are performed--initiated by new technologies--have had a significant impact on the way that finance operates.
Such changes followed a predictable pattern. Banks would use computing for a small activity, such as data collection or modeling, which would change the way a banking function was performed. Since banking was such a conservative industry, this small change would be tested out carefully. Once it demonstrated that it could increase productivity, it would be widely adopted throughout the industry, thanks to the power of the American Bankers Association (ABA), which led the banking industry forward.
One example: making a loan. James W. Cortada, author of the forthcoming The Digital Hand, Volume 2 (Oxford University Press), explains this change. In the 1950s, if a borrower wanted a loan, he or she would fill out a paper application. Six to eight weeks later, the bank's credit committee would meet and decide whether the borrower was creditworthy and, if so, set the loan's interest rate.
By the 1960s, mainframe computers permitted the rise of companies that produced standardized credit ratings, thus enabling banks to outsource a portion of the credit granting process--credit rating--to companies such as TRW. Once banks found that they could reliably extend credit to borrowers rated B or higher by TRW, the entire banking industry outsourced credit analysis.
In the 1980s, banks realized that computers could free them from keeping loans on their books until they were repaid. With standards for rating the riskiness of loans, banks could electronically divide up the loans into pieces with common cash flow characteristics and sell them to other financial institutions. This added tremendous liquidity to loan markets, particularly the mortgages used to finance home purchases.
More significantly for banks, the ability to sell off portions of their loan portfolios opened up new sources of revenue. Rather than simply holding on to a loan and profiting from the interest received throughout the loan's life, banks could now add a new revenue source--the fees from originating loans and selling them to other institutions.
This evolutionary path in banking parallels the way companies' treasury operations have extended credit to their customers. Just as banks outsourced credit checks, so did companies. In some cases, the ability to analyze customer payment patterns and to package their receivables enabled treasurers to raise capital by selling the receivables to banks and others.
Middleware was the key technical innovation that permitted the evolution of computing from mainframe-based to distributed PC-based applications. Middleware is software that emerged in the 1980s to link then new, PC-based applications to older mainframe-based legacy systems. Middleware also made it possible to connect multiple applications to create a larger application--known as distributed processing.
* Limited Evaluation of Planning Scenarios [right arrow] Infinite Evaluation of Planning Scenarios
Advances in IT have fundamentally transformed the way finance evaluates capital investments. In the past, when companies developed forecasts--on wide pieces of paper--of the net present value (NPV) of building a new plant or making an acquisition, it simply took too long for managers to evaluate endless permutations of what might happen. Decisions were probably made more quickly as a result.
But with the emergence of electronic spreadsheets in the 1980s, capital investment decisions became subject to what FEI member Joseph Barkley, senior vice president of American International Group (AIG), calls "the endless 'what if.'" Microsoft's Excel spreadsheets made it possible to examine a seemingly endless array of permutations. But it also made it easier for finance to produce far more sophisticated-looking justifications for whatever management wanted.
Indeed, Mitch Kapor, founder of Lotus Development Corp., the maker of Lotus 1-2-3, noted that spreadsheets had created an entirely new class of computer user. In a May 1986 Financial Executive article, "Is There Life After Spreadsheets?," Kapor pointed out that people who had previous experience with computers were "catching the excitement" of personal computers. Kapor predicted that better analytical tools for optimization and sensitivity analysis would make it possible to put real corporate data in spreadsheets.
Kapor's prediction was prescient. Excel spreadsheets remain important tools for analysts to develop budgets and forecasts. But two relatively recent technology developments have broadened the kind of information that analysts can access readily. The first development is enterprise resource planning (ERP) systems, which--although expensive to implement--can make available financial data spanning the entire cash cycle from purchasing inputs to collecting invoices.
The second development is the growing popularity of business intelligence (BI) programs from companies such as MicroStrategy and Cognos, which enable analysts to pinpoint business opportunities by analyzing huge volumes of transactional data. For example, eBay uses business intelligence software to analyze the performance of 16 million items listed across 27,000 categories of products and services for sale on its website.
Excel spreadsheets still serve as a very easy-to-manipulate means of analyzing all this data. But ERP and BI have vastly broadened and deepened the quality of the data that populates spreadsheets. The result is more credible and useful analysis for decision-making for finance executives.
* Isolated Functional Departments [right arrow] Integrated Cross-functional Processes
The notion of specialized functions goes as far back as the 1700s and Adam Smith's Wealth of Nations. Smith imagined that a pin factory that had adopted a "division of labor" might produce tens of thousands of pins a day, whereas a pin factory where each worker attempted to produce pins from start to finish--performing all the tasks--would produce very few pins. Companies widely adopted this division-of-labor concept. Traditional business functions such as engineering, manufacturing, logistics, sales and finance worked mightily to maximize their individual performance. Since many businesses were focused on efficiently meeting ever-growing demand for their products, this division of labor often produced lower unit costs.
Computing was similarly isolated and centralized. By 1969, data processing (DP) specialists, often dressed in long white coats, deemed the "high priests," controlled access to huge mainframes--such as IBM 360s--whose programs were encoded in punch cards. Each night, the priests would run these programs through the mainframes that would spew out piles of paper printouts. They would tear the printouts into chunks for each department that submitted programs, and the process would start all over again the next day.
In the 1970s, minicomputers emerged--eroding the power of this priestly IT caste. Minicomputers--such as Digital Equipment Corp.'s (DEC) PDP-11s and VAXs--made it possible for different departments to do their own computing rather than wait on the centralized DP department. Moreover, the ability to connect computers electronically made it possible for different departments to share information, and even for companies to share information with their suppliers and customers. This kind of "distributed computing" opened up tremendous possibilities for improved effectiveness and efficiency.
However, the full economic benefits of distributed computing could only be achieved through significant organizational change. In "The 'Electronic' Financial Executive," (Financial Executive, March, 1964), John A. Griswold, a professor of Finance at Dartmouth's Amos Tuck School of Business, anticipated "much greater integration between units of a business." Griswold cited the thinking of Neal Dean, a business executive who anticipated a world in which computers would connect different departments within companies and would also link these companies with their suppliers and customers.
In many organizations, Dean's vision has yet to be realized. However, the reengineering movement of the 1990s helped bring this vision closer to reality for many. Instead of operating isolated finance department functions, such as sales order processing, credit analysis, billing, collections and cash management, many companies have achieved the full potential of integrating distributed technology--including personal computers (PCs) from the likes of IBM, Compaq and Dell connected to servers from Hewlett-Packard (HP), Sun Microsystems or IBM--by focusing management attention on optimizing the entire cash cycle. Such process optimization can help turn a company that is hemorrhaging cash into one that accumulates it.
This was what happened when reengineering management-consulting firm Booz Allen Hamilton's cash collection cycle, says Schwartz, who was the company's CFO at that time. With his extensive experience analyzing business processes combined with his knowledge of the consulting business, he took a hard-nosed look at the opportunities to improve the firm's cash cycle.
His analysis showed that the firm was taking too long to send out its bills. So, he instituted a policy of sending bills out two weeks earlier than previously, and he encouraged partners to collect more aggressively. The result was that Booz Allen received its cash more quickly--a change that radically reduced the level of borrowing that the firm required to operate its business.
Schwartz's observations about the growing role of the CFO in managing business processes was also borne out in a May 1986 Financial Executive article, "Technology: How Is It Changing the CFO's Job?" In it, he analyzed the results of a survey of financial executives--finding that 60 percent of the respondents had been responsible for IT for four years or less, despite their lack of technical background. A New England CFO noted that "the CFO of the future will need to begin evaluating IT requirements, expenses and control, or a new function at the senior level will fill the vacuum."
* Many Separate Geographic Subsidiaries [right arrow] Centralized Global Shared Services
Advances in computing, coupled with ever-deepening globalization, have driven significant changes in the way finance functions are performed around the world. In many companies, country subsidiaries had their own finance staffs that performed functions ranging from financial accounting to cash management. While this form of organization enabled finance to respond quickly to the needs of country subsidiaries, it did not provide the optimal outcome for the corporation.
Many companies are taking advantage of new technologies to enhance finance's productivity by reducing the number of subsidiary finance departments--pushing finance into a far smaller number of shared-services centers, located in countries where the work can be performed at lower cost. Oracle has used this global shared-services center concept to transform its operations.
Henley says, "We design business practices and processes to be done globally." With low-cost Internet access, telecommunications and powerful computing, Oracle was able to centralize many of its finance functions and establish consistent procedures globally. As a result, Oracle has been able to shift its global shared-services centers to countries such as India and China, where cost savings can be quickly realized. Also, following the passage of the Sarbanes-Oxley Act in 2002, audit committees of public companies have grown increasingly concerned about the consistency and transparency of a company's controls. In Henley's view, Oracle's efforts to centralize, globalize and standardize have made finance more useful to the business and more transparent to regulators.
* Finance as Support Function [right arrow] Finance as Business Partner
Finance has become more of a business partner to the CEO than it was 75 years ago. This should not be overstated, however, since many of today's finance departments have yet to achieve this transformation. Having said that, finance has traditionally supported the business by generating information to manage operations, liaising with banks and other capital sources, managing relationships with regulators such as the SEC and the Internal Revenue Service (IRS), overseeing customer billing and collection and assuring that employees get paid. Finance departments continue to provide most of these support functions today.
What has changed, thanks to technology, is that many finance departments now work in partnership with line executives to formulate and execute strategic decisions.
And, make no mistake--a big part of this transformation in the role of finance depends greatly on the interpersonal skills of the CFO and key financial executives. Henley describes such CFOs as "strategic leaders with business sense, analytical skills and communications skills."
But technology has certainly helped as well. For Schwartz, the power of distributed computing has freed companies from the mainframe "high priests." The ability to share information across departments--that Dean foresaw in the early '60s--enabled Schwartz to pursue what he calls a "velvet glove, steel-fist" approach to building management information systems. Schwartz tapped distributed technology to produce information that transformed finance into a value business partner by following four key principles:
1. Enter information into the system only once;
2. Access that information wherever it is needed;
3. Make sure that all authorized people can access the information; and
4. Assure that the finance department knows what people are doing with the information.
As finance has gained a seat at the top executive table, it has increased its control over administrative resources. In many companies, the CFO's direct reports include IT, real estate, procurement and human resources, as well as all finance--all the areas that AIG's Barkley says "represent big money." By building reliable systems for budgeting and tracking financial resources for these functions, the CFO has gained the power to control costs for companies under pressure from Wall Street to exceed quarterly earnings targets. Since it can sometimes be challenging for managers to beat quarterly revenue targets, the ability to bring costs under control rapidly is crucial for creating shareholder value.
So, what does this history tell us about how the finance function might look 75 years from now? It would not be a surprise if finance's various functions continued to be performed--but they would continue to change and be done at a much lower cost than today. Technology would make it possible to perform many of the most process-intensive activities--such as billing and collections--with virtually no human intervention. Furthermore, more powerful portable technologies will let businesses operate and help managers make decisions without expensive offices. But there will still be a need for analytical experts on increasingly complex accounting and tax rules, and who can work well with people. So, in 2081, some of finance's historical verities will likely remain.
Perhaps it will be a case of deja vu. In "Imaginative Use of the Computer," (Financial Executive, September 1970), Maurice S. Newman, a partner with Haskins & Sells wrote: "We are really only at the beginning of this revolutionary era of quantitative analysis and we can only see through the glass darkly where it will lead. There is no doubt, however, that it will be an era of profound change." And it is likely, FEI will be there, providing guidance and more.
Peter S. Cohan is president of Peter S. Cohan & Associates (www.petercohan.com), a management consulting and venture capital firm, and a management professor at Babson College in Wellesley, Mass. (www3.babson.edu/academics/faculty/Cohan.cfm). His seventh book is "Value Leadership: the 7 Principles that Drive Corporate Value in Any Economy" (Wiley, 2003).
RELATED ARTICLE: FEI's Committee on Information Management in the 1970s: Conflicts Between Finance and IT
The change in the committee's name--from Committee on Information Management, or CIM, to its current one, the Committee on Finance and Information Technology (CFIT)--is symptomatic of the changing role of information management, and the struggles that the committee faced during my involvement. Those struggles focused on the difference between information management and information technology, both for financial management and financial support to general management.
First, envision the setting for the use of information technology in those days. We had just left 80-column card files for large mainframes. I can recall in the early 1970s becoming the COO of the Westinghouse Broadcasting direct mail division. As a group finance executive, I suggested solutions to the files and operating mess in that division, caused by backing up the files--literally backing up the truck carrying the decks of cards to a new location, and destroying the files.
The focus, then, was on hardware, and to some extent on free-standing software applications, particularly general ledger and consolidation packages. No one knew much about personal computers, and there was little sense of networking; so users were dependent on others--who as intercessors often acted as high priests and druids--to process information, provide output reports and resolve problems. The good news was that it was easier to have control with this greater centrality and with fewer people involved. The bad news is that users did not understand the capabilities and could not express their desires; and the priests did not understand the business needs and values. So, solving a business problem with computer technology was usually a random event.
The basic issue was: do we focus on technology to provide greater capacity for faster processing and turnaround; or, do we try to solve business problems within the equipment limitations?
Let me illustrate this with a problem that I had to solve in the early '70s. When I became CFO of Booz, Allen & Hamilton, we had really ineffective and unresponsive support systems. I was supposed to fix this, and I did. I focused on information that my team needed for financial management--that partners and staff needed to serve their clients and conduct projects, and that management needed to run the business.
This information-management approach led to a very early application of database management, and led to superior benefits to all parties. For example, our competitive success rate improved as we got the right people on the right assignments; our receivables reduced as we billed on the project cycle and not on the closing cycle; our productivity increased as we enabled people to manage time better; and our closing cycle dropped from weeks to days.
At the onset of this effort, my controller wanted to install an improved general ledger package. Had we done so, we would have a better solution than what had been in place, but it would have been an isolated solution of limited value to the business.
So, I was not a fan of technology--be it applications, or hardware or infrastructure--as such. I was a fan of the benefits of organizing and using information to improve management, and applying supporting technology. That is the difference between a focus on information management and information technology.
As FEI's committee became more interested in the technology, I became less interested in the committee. I felt that solving a management problem, and managing information, had to supersede technology solutions. I still feel that way. Now, recognize that there was a justification for the committee's focus. As more CFOs were becoming in charge of IT, and as IT moved from a narrow focus on supporting the financial processes, to a broader focus, supporting a broader array of business needs, CFOs had a growing need to understand the demands and requests being made on their IT departments.
Flattening the world--through networks and desktops, among other technologies--makes it much easier to access information, but it puts an even greater premium on the quality of the information accessed. For example, being able to access a company policy and procedure is a great advance from hard copy, but it means that the policy and procedure must be current and relevant. So, I suspect that the struggle of the '70s is still important, but it's now based on different technologies, with different management problems to solve.
By Malcolm Schwartz
Malcolm Schwartz, a long-time FEI member, was active on FEI's Committee on Information Management (CIM) during the 1960s-70s. He comments about CIM and how the growing role of information technology (IT) was addressed by the committee, and its effect on the committee--and on him personally.
|Printer friendly Cite/link Email Feedback|
|Title Annotation:||information technology|
|Author:||Cohan, Peter S.|
|Date:||Jul 1, 2006|
|Previous Article:||Linsmeier new FASB board member.|
|Next Article:||Quest for returns boosts private equity: leveraged buyouts and other deals led by private equity firms are all the rage these days. Insipid stock...|